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Monday, April 25, 2011

Reader Patrze sent to me a link to the FDIC's March 2011 "Don’t Bet the Farm Symposium" held in Arlington, Virginia. Among those who spoke at the symposium was FDIC Chairman Sheila Bair. I have reviewed the transcript [pdf] and have chosen to feature the presentation by Jim Farrell.

Jim has served as President and CEO of Farmer's National Company in Omaha, Nebraska since 2004 and also serves as Chairman of the Board. Jim currently serves as Chairman of the Board of Directors of the Federal Reserve Bank of Kansas City’s Omaha Branch office. Jim is an accredited farm manager and serves on the Editorial Board for AGRA Marketing Magazine. Jim grew up on and operated a family grain and livestock farm in Northwest Iowa. He holds a bachelor's degree from Iowa State University.

To any readers here who are trying to keep up on the state of farmland prices, this is good reading from, perhaps, the most knowledgeable expert in the country on the subject of farmland sales, operation, and management.

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JIM FARRELL:I get the pleasure of being the last presenter today and as such, I was thinking about everything that had been said this morning. And there were a lot of interesting comments today. I'm old enough that I graduated college in 1976 and lived through the 1980s that we have talked about a lot today. Bill Isaac’s memories were kind of interesting, very interesting actually. I was a farm credit borrower in the late seventies and into the early eighties, and I found his comparison to the seventies a little sobering, I guess, when he took a step back and took a look at the comparison of what's going on in the economy, not what’s going on in agriculture.

I found it very interesting those comparisons—from the deficit spending, entitlements out of control, the great war expense we had at that point in time, the lower dollar value which I remember increasing exports, and the value of cropland was going up substantially. I remember my dad cash renting a farm in 1973 across the road from where we lived for $40 an acre. And I think it was 1974, my years might not be quite right, but I think it was 1974 that the rent went to $80 and 1975 it went to $100. And that was just unreal. My dad quit raising cattle that year because he said he had made too much money in cattle to lose it all in one year as feeders had gone up close to $500 and so on.

So those things are all kind of rolling through my mind this morning as I listen to the recap of the 1970s. I also found very interesting Chairman Bair's comments about extreme volatility in agriculture. That's something we try to look at in our company as we take a look at what is going on and look back on our experiences. My management team is mostly about the same vintage as I am. Sometimes that's good and sometimes that's bad because we have a tendency to remember things that maybe make us too conservative, but we look at things conservatively.

Let me give you a little background on our company; I know many of you in the room, but I know there are some I do not. We're located in Omaha, Nebraska. Our company was founded in November of 1929, interestingly enough, which was of course during the Great Depression. Our company today manages farms for absentee or non-operating land owners; primarily, these are folks who inherited it, but we also have investors that we manage for. We manage about 5,000 farms today in 24 states or about 2.5 million acres. We also sell farms, and we’ll sell about 650 farms a year. That’s what we sold last year, or about $330 million in real estate last year. Approximately 197 of those sales were auctions. So my perspective on the land market is pretty close as far as what's going on.

We have an appraisal business within our shop as well, and we have 17 appraisers on staff. We diversified in the early 2000s into the oil and gas business kind of thinking at that point that maybe the two wouldn't track identically. However, they have, interestingly enough. We manage about 70,000 oil and gas interests today in 36 states out of our offices in Tulsa. We also offer farm related insurance products including revenue products among some other lines of business we have, but we're focused on land and landowner related services.

I thought I would cover just a couple of basics today. There was some discussion about who is buying land and who is selling land and I thought that I would add to the discussion. The non-operating land owner is the primary seller of farmland today. While there are farm operators that sell land, they are few and generally they are selling to consolidate. Even retired farmers generally don't sell the farm; they may, but generally they don't. So of the farms that we sell, over 90 percent would be non-operating land owners, most of who are over the age of 65 and are inheritors of the land. There's also going to be a high percentage of multiple owners. And they grew up on it or perhaps purchased the farm next door but that's commonly their connection to it.

We have seen a real sharp drop in the number of folks wanting to sell their land. Over the last 24 months, about 40 percent fewer of our clients are selling land today compared to what we saw on average the previous eight years. Monetary policy, and uncertainty about the economy are both affecting those decisions as well as concern about inflation.

From a monetary perspective, there is nowhere that land owners feel comfortable putting the money if they did sell the farm. The farm is showing a better return than their alternatives so they're hanging on to the farm. And so people that typically were selling in past years currently are not, and that's created a little bit of a sellers’ market in farm real estate. We have many more buyers than we have sellers due in part to that reluctance to sell.

On the land buyers side about 75 percent of the land we sold is to farm operators who live in the local area. The local area is broader than it was in the past; it might be 20 to 30 miles. Twenty-five percent of farm land is sold to investors and I agree with comments made on the first panel, that there's not a large influx of the large fund investors, but there are some. Of the 25 percent of land we see going to investors through our shop, about half of that is going to that non-operating land owner who is buying add-on pieces to what they already own or maybe going back to the area where they were raised and buying another farm. So maybe 10 to 12 percent of land sales we're seeing are to what might be a new investor, someone who is not familiar with agriculture, that didn't grow up in the area, and who doesn’t otherwise have a connection to the land.

We saw a lot of interest in the mid 1980s from that same group of folks, people calling up asking how to buy farmland by the foot, by the pound, and so on. I remember those calls when we came off the last ag crisis. The difference now is that we have substantial companies and individual investors that are buying. They are putting together portfolios and they are performing on it, which we didn't see nearly as much of during the 1980s. There was some but it is much more prevalent today.

The cap rate was mentioned earlier; it was 5 percent that was required two years ago. In the mid 1980s, we managed a portfolio for Morgan Stanley and they required 7 percent before they would buy. Today, it's hard to get in parts of the Midwest a 3.5 to 3.75 percent cap rate.

Another phenomenon that we have observed in our appraisals, and I would imagine that Ken could tell us the same thing, is that a third to a half of the land that's trading is trading quietly and is trading below market. Nobody knows it traded unless you're an appraiser and you’re digging in the courthouse and you find the records. These are arms-length transactions and are not necessarily father selling to son, and the similar. A lot of non-operator owners, which as a group own over half the farmland, aren't well versed with current land values, and when somebody calls and makes them a purchase offer, they're selling the land and they are selling it kind of quietly. And so there's a fair amount of transaction going on underneath what we might typically consider the market when we're selling land by auction or private treaty.

Regarding risk management, and I’ll wrap up here on a couple of comments on risk management, the commodity marketing that was mentioned earlier is something I think that most farmers are trying to utilize better today than they did in the past. They are being more aggressive in selling into the markets. We're currently fairly well sold out of our 2010 crops for our clients. We have sold a sizeable portion of our 2011 crops as well and we have some clients that have even sold 2012 and we have farm operators that are following much of the same patterns looking forward trying to put an income stream together on these high prices. And that's been difficult at times in this market; I have had clients call me that are upset with me because we sold their corn at $4.50 a bushel. You know $4.50 is not a bad price for most of us, but when corn is a fix, those decisions get really tough.

When I joined Farmer's National about 8 percent of our leases were cash rent. Today, 43 percent of our leases are cash rent. And so there is substantial shift of risk, if you will, from some sort of a shared environment to the farm operator. And that's often driven at the farm operator's request. That's not been driven at our request. About 39 percent of our leases are crop share of our farms and 18 percent are custom.

Crop share leases are quietly disappearing, and the customs are increasing where we hire the work done to put the crop in. On the cash rents, we collect nearly all of them up front which is a risk management tool for us because we oftentimes can't perfect our liens well enough on the second half of the cash rent to protect our client's interest. We have seen a lot of variable rate cash rent come to the market. It’s becoming more prevalent to use crop insurance as a formula where you take a ten-year average yield and you build some sort of a factor from that ten-year average yield considering the current crop price that's protected by crop insurance, which was announced about a week ago or so and which I think is $6.02 or $6.04 for corn. Looking at the fall price and doing a formula based on that, if your yield is above your average, you have a factor that creates more cash rent and if you have a poor yield, the farm operator has some protection.

We're also seeing blended share leases in the market, although not as many as I thought we might. We started to see a push for more blended shares and share crops again in 2008, but not much since then. Times have been good and farmers continue to want to cash rent. The blended shares is where the owner of the farm pays for the seed, fertilizer, and herbicide, and the operator provides or pays for all the labor and machinery and then they split the crop, but not 50/50, it's a higher percentage to the owner.

We also see the revenue insurance product as a really great tool that was not available in the late 1970s and early 1980s. Multi-peril doesn't hold a candle to the insurance products we have today, and we encourage our clients to review those products and our farm operators are also doing the same. It’s a year right now, similar to 2008, when you can buy up in the spring months and protect yourself against a falling grain price. And that's a really good risk management tool that is available.

Now that's a year-to-year basis, beyond this year you’re rolling the dice a bit as you look at land values. Most land loans are on fixed interest and are at very competitive rates, which is a much different scenario than what I saw when I was first starting out in ag. I would say some are more aggressive, we occasionally see loan-to-values as high as 75 percent, but I would say that's not the norm although there's certainly a lot of competition, Ken can attest to that in the market today for land loans, especially from good operators.

Finally, at our Federal Reserve Bank of Kansas City’s Omaha Branch Board meeting last week, some of the bankers on the Board reported that they have farm operators with cash in the bank as they're going into spring planting, and that's highly unusual. Their farm operators have bought machinery, they have bought some land maybe, and they still have excess profits on deposit in the bank which is really different than how most farm operators operate. Most farm operators don't like to operate with their own cash; they would rather operate on someone else's.

To follow, are Farrell's answers during the Q&A session:

A: I have a son who has just started in business in Omaha about nine months ago, and I have preached to him a lot about cash is king. You need to have cash flow; cash flow is much more important than equity. So that would be a very quick simple lesson from my perspective. Not being a banker, I'll let my fellow panelists address it from their perspective.

A: Rich, I would add a reflection on your question of what did I learn specifically in the 1970s and 1980s. This is something we talk about in our company all the time. Our revenue dependency is just like the farmer’s; it's the value of the grain, the value of the rents, the value of the land, the value of the oil and natural gas. So we watch these things very closely. And when I look back at the 1970s and to the 1980s when I started managing farms and acquired properties for lenders in those days, it was the operating capital that initially caused the problems in the 1970s and 1980s. It wasn't necessarily the land loans—I’m not saying the land loans weren't a contributor—but my point is that a lack of operating capital and the inability to operate the farm is where it started. And that led to the inability to pay the long-term debt. Somebody mentioned this morning on the panel that operating leverage today is something that we need to watch because it can cost $500 to $800 an acre or more to plant an acre of corn today depending on where you're at. So when you push your cash rent on top of that, operating capital is very crucial.

A: I can comment on what it's meant to land values. We have seen quite a number of what we consider older farmers buying property and paying essentially cash for those properties because they can't put the money in the bank and get any kind of a decent return on it and they're reluctant to put it into something else that is more risky. If we had a 4.5 percent CD rate, the market would probably fundamentally look a lot different than it does right now. We sold a farm twelve months ago in York County at auction, a short-quarter, pivot-irrigated 140 acres for $8,200 an acre without the pivot and it had a cash rent lease for that year around $180 or $190. The farmer bought it for his son-in-law to farm, and this farmer was in his seventies. As best as we can tell, he paid cash or nearly all cash on this $1.2 million sale. That is the effect that we’re seeing in the market.

A: We're not really directly affected by the regulatory environment within the banking industry as such, but we are more in an indirect way. We work with a number of publicly-traded companies, and in those companies where we manage properties for them through a trust department relationship, we are not unlike what Matthew was talking about needing two people there for compliance. We have had to beef up staff considerably to meet SAS 70 audit requirements. We have to go through SAS 70 audits for two of our business lines every year. We have added substantial infrastructure for that. Some is good, but some you step back and look and it's not. So we're affected by regulation but just not the same way.

3 comments:

It was disappointing that an entire seminar on farmland left out the most important spokesperson for the industry. No farmers were on the panel and it would have been nice to have their important input and perspective on such a headliner topic.